REIT Income From Tax Credits Is Qualifying Income

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No.: * * *
Telephone Number: * * *

Index Number: 856.00-00
Release Date: 12/6/2019

Date: September 09, 2019

Refer Reply To: CC:FIP:B01 - PLR-103656-18

LEGEND:

Taxpayer = * * *
Subsidiary = * * *
Manager = * * *
Partnership = * * *
DE 1 = * * *
DE 2 = * * *
Agency = * * *
Act = * * *
Protocol = * * *
Organization A = * * *
Organization B = * * *
Category A = * * *
Country = * * *
State A = * * *
State B = * * *
States = * * *
Year 1 = * * *
Year 2 = * * *
Year 3 = * * *
Year 4 = * * *
Year 5 = * * *
Date 1 = * * *
a = * * *
b = * * *
c = * * *
d = * * *
e = * * *
f = * * *
g = * * *
h = * * *
i = * * *
j = * * *
k = * * *
l = * * *
m = * * *
n = * * *

Dear * * *:

This responds to a letter dated February 7, 2018, and subsequent correspondence, submitted on behalf of Taxpayer. Taxpayer requests certain rulings regarding the treatment of income from credits issued by Agency, pursuant to the State B Program, beginning in Year 5 (“Agency Credits”) and from credits issued by the Organization A Program beginning in years after Year 5 (“Org A Credits,” together with Agency Credits, “Credits”) for purposes of its status as a real estate investment trust (“REIT”) under section 856 of the Internal Revenue Code (“Code”):

FACTS

Taxpayer is a State A limited liability company that has elected under section 856 to be treated as a REIT for federal income tax purposes.

Taxpayer owns an a percent limited partnership interest in Subsidiary, a State A limited partnership classified as a partnership for federal income tax purposes. Manager owns a b percent general partnership interest in Subsidiary. Taxpayer and Subsidiary each employ the accrual method of accounting, and the taxable year of each is the calendar year.

Subsidiary owns (including through limited liability companies classified as either partnerships or disregarded entities for federal income tax purposes) approximately c acres of timberlands located in Country and States with an aggregate estimated fair market value of approximately $d. Manager directly or indirectly manages Subsidiary, which realizes income and gain through timber sales and occasional sales of timberlands.

Taxpayer represents that Subsidiary indirectly has k projects under development on certain portions of its existing landholdings, and that the projects qualify or will qualify under one of the two carbon offset programs described below.

Subsidiary holds a l percent membership interest in Partnership, a limited liability company classified as a partnership for federal income tax purposes. Manager owns the remaining membership interest in Partnership. DE 1, a disregarded entity of Partnership, currently has b carbon offset projects under development pursuant to the State B Program. DE 2, a disregarded entity of Subsidiary, currently has b carbon offset projects under development pursuant to the Organization A Program.

State B Program

In Year 2, State B enacted Act in an effort to reduce greenhouse gas (“GHG”) emissions. Act created State B's cap-and-trade program whereby State B sets a hard cap on overall GHG emissions but allows certain businesses to buy, sell, and trade the rights to produce emissions (the “State B Program”).

Agency administers the State B Program on behalf of State B. Under the State B Program, Agency issues Agency Credits in exchange for a project developer engaging in activities on U.S. landholdings that affirmatively reduce GHG emissions. Agency's protocol describes the standards that each carbon offset project must satisfy (the “Protocol”). Each of DE 1's carbon offset projects under the State B Program (the “State B Projects”) are predicated on the use of specified parcels of DE 1's timberlands located in States to reduce atmospheric carbon dioxide.

Per the Protocol, Agency will issue DE 1, one Agency Credit for each metric ton of carbon dioxide removed from the atmosphere by each project. To ensure that its timberlands will process a sufficient amount of carbon dioxide to meet the requirements of the State B Program, DE 1 must continuously monitor its compliance with the Protocol. Agency will hold each of DE 1's State B Projects to rigorous reporting standards to demonstrate the effectiveness of its efforts. Thus, to qualify for Agency Credits, DE 1 must undertake certain affirmative obligations and agree to certain restrictions on the use of the specified parcels of each project's timberlands for e years, including:

If the total stock of trees in a project decreases over any consecutive h-year period, DE 1 will be obligated to return some or all Agency Credits issued to DE 1 (or acquire Agency Credits to be relinquished). Land-use restrictions, to which DE 1 agreed to abide by under the State B Program, are restrictions that could be recorded as easements under local law, although DE 1 is not presently contemplating doing so.

In Year 5, Agency issued Agency Credits to DE 1. Taxpayer represents that DE 1 expects to be issued additional Agency Credits in years beginning after Year 5.

Organization A Program

Organization A, created in Year 1, is a third-party provider of GHG emission standards. In Year 2, Organization A launched a voluntary GHG offset credit program under which a project that removes GHGs from the atmosphere may receive Org A Credits from Organization A that can be sold to individuals or entities that produce GHG emissions (the “Organization A Program”).

Org A Credits issued by Organization A are not tied to any specific cap-and-trade program; they may not be used to satisfy the legal obligations of polluting businesses. Instead, Org A Credits may be purchased by businesses or individuals that wish to quantify and demonstrate their efforts to reduce their net emissions.

The Organization A Program offers a number of eligible project categories, one of which is Category A. Eligible Category A activities are those that reduce net GHG emissions by reducing deforestation, degradation of forests, or both. These include activities that are designed to stop planned deforestation.

DE 2 owns and operates b projects, located in Country and comprised of i hectares of mature timberland (“Property”), that adhere to the requirements and restrictions applicable to projects described under Category A (the “Category A Projects”).

Category A activities, designed to stop planned deforestation, include a landowner's agreement not to convert timberlands to a non-eligible Category A use (“Non-Eligible Use”). Prior to initiation of DE 2's Category A Projects, the Property was under imminent threat of conversion to agriculture, a legally permitted, Non-Eligible Use.

For the Category A Projects to be eligible for the issuance of Org A Credits from the Organization A Program, DE 2 has undertaken certain affirmative obligations and agreed to certain restrictions on the use of the Property for the duration of the crediting period ending on Date 1 (“Crediting Period”). These include:

Only after Organization A reviews and approves an application for Org A Credit issuance, will it issue Org A Credits, either in a single year or over a period of years, based on the net amount of GHGs removed from the atmosphere each year above a predetermined baseline established for the project.

Organization A reviewed DE 2's completed application, including reports from the third party that conducted the validation and verification and additional documentation submitted by DE 2 directly. Organization A approved DE 2's application, and the Organization A Program issued Org A Credits, as a single issuance, to DE 2 in Year 3. Taxpayer represents that DE 2 expects to be issued additional Org A Credits by the Organization A Program in years after Year 5. Irrespective of whether Organization A Program were to issue the Org A Credits in a single year or over a period of years, a specified percentage of those Org A Credits will be held in a buffer account.

After Org A Credits have been issued, the Category A Projects must continue to be periodically validated and verified in the manner described above. If, at any time during the Crediting Period, the Category A Projects fail to reduce atmospheric GHG emissions in accordance with the predetermined standard, Organization A may cancel some or all of the Org A Credits held in the buffer account. DE 2 has the option to extend the Crediting Period beyond Date 1, so long as it continues to meet the Category A and Organization A Program requirements and restrictions, including refraining from converting the Property to a Non-Eligible Use. Land-use restrictions to which DE 2 agreed to abide by under the Organization A Program are restrictions that could be recorded as easements under local law, although Subsidiary is presently not contemplating doing so.

Credit Sales

Taxpayer represents that DE 1 and DE 2 expect either to sell Credits in one or more transactions to unrelated third-party purchasers or to transfer Credits to a taxable REIT subsidiary of Taxpayer that will sell them to unrelated third-party purchasers. Taxpayer further represents that neither Taxpayer, Subsidary, Partnership, DE 1, nor DE 2 intends to hold Credits for purposes of speculating on future appreciation.

LAW AND ANALYSIS

Section 61(a) defines gross income as “income from whatever source derived,” except as otherwise provided by law. See Treas. Reg. § 1.61-1(a). Gross income includes income realized in any form, whether in money, property, or services. Id. This definition encompasses all “accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431(1955).

Section 451 and the regulations thereunder provide rules for determining the taxable year of inclusion for items of gross income.

Under an accrual method of accounting, unless section 451(b)(1)(A) requires earlier inclusion, an item of gross income is generally includible when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. All the events that fix the right to receive income generally occur upon the earliest of the following: (1) the required performance takes place, (2) payment is due, or (3) payment is made. See Schlude v. Commissioner, 372 U.S. 128 (1963); Rev. Rul. 2003-10, 2003-1 C.B. 288. However, section 451(b)(1)(A) sets forth special rules requiring earlier inclusion in the case of certain accrual-method taxpayers.

Section 856(c)(2) provides that for a corporation to qualify as a REIT for any taxable year, at least 95 percent of its gross income (excluding gross income from prohibited transactions) must be derived from sources that include dividends, interest, rents from real property, gain from the sale or other disposition of stock, securities, and real property (other than property in which the corporation is a dealer), abatements and refunds of taxes on real property, income and gain derived from foreclosure property, certain commitment fees, and gain from certain sales or other dispositions of real estate assets.

Section 856(c)(3) provides that for a corporation to qualify as a REIT for any taxable year, at least 75 percent of the corporation's gross income (excluding gross income from prohibited transactions) must be derived from rents from real property, interest on obligations secured by real property, gain from the sale or other disposition of real property (other than property in which the corporation is a dealer), dividends from REIT stock and gain from the sale of REIT stock, abatements and refunds of taxes on real property, income and gain derived from foreclosure property, certain commitment fees, gain from certain sales or other dispositions of real estate assets, and qualified temporary investment income.

Section 856(d)(1) provides that rents from real property include (subject to exclusions provided in section 856(d)(2)): (A) rents from interests in real property; (B) charges for services customarily furnished or rendered in connection with the rental of real property, whether or not such charges are separately stated; and (C) rent attributable to personal property leased under, or in connection with, a lease of real property, but only if the rent attributable to the personal property for the taxable year does not exceed 15 percent of the total rent for the taxable year attributable to both the real and personal property leased under, or in connection with, the lease.

Section 856(c)(5)(J) provides that to the extent necessary to carry out the purposes of part II of subchapter M of Chapter 1 of the Code, the Secretary is authorized to determine, solely for purposes of such part, (i) whether any item of income or gain that does not otherwise qualify under sections 856(c)(2) or (c)(3) may be considered as not constituting gross income for purposes of sections 856(c)(2) or (c)(3), or (ii) whether any item of income or gain that otherwise constitutes gross income not qualifying under sections 856(c)(2) or (c)(3) may be considered as gross income that qualifies under sections 856(c)(2) or (c)(3).

Section 1.856-4(a)(1) provides that, subject to the exceptions of section 856(d) and § 1.856-4(b), the term “rents from real property” means, generally, the gross amounts received for the use of, or the right to use, real property of the REIT.

Under § 1.856-3(g), a REIT that is a partner in a partnership is deemed to own its proportionate share of each of the assets of the partnership and to be entitled to the income of the partnership attributable to that share. For purposes of section 856, the interest of a partner in the partnership's assets is determined in accordance with the partner's capital interest in the partnership. The character of the various assets in the hands of the partnership and items of gross income of the partnership retain the same character in the hands of the partners for all purposes of section 856.

The legislative history underlying the tax treatment of REITs indicates that a central concern behind the gross income restrictions is that a REIT's gross income should largely be composed of passive income. For example, H.R. Rep. No. 2020, 86^th Cong., 2d Sess. 4 (1960) at 6, 1960-2 C.B. 819, at 822-23 states, “[o]ne of the principal purposes of your committee in imposing restrictions on types of income of a qualifying real estate investment trust is to be sure the bulk of its income is from passive income sources and not from the active conduct of a trade or business.”

Unless section 451(b)(1)(A) requires earlier inclusion, income with respect to the issuance of Credits will accrue under section 451 upon the earliest of the following events to take place: Credits are earned, Credits are received, or Credits are due. Taxpayer's proportionate share of DE 1 or DE 2's basis, as applicable, in each Credit will equal the proportionate share of the fair market value of such Credit accrued as income by Taxpayer. Cf. Philadelphia Park Amusement Co. v. United States, 126 F. Supp. 184, 188-189 (Ct. Cl. 1954). However, Taxpayer's proportionate share of income with respect to the issuance of Credits, by either the State B Program or the Organization A Program, constitutes gross income that is not listed as qualifying income under sections 856(c)(2) or (c)(3).

Subsidary or Partnership will indirectly earn Credits by agreeing to certain restrictions on the use of its land for a specified term of years. Both the State B Program and the Organization A Program impose land-use restrictions by requiring Partnership and Subsidary to abstain from certain uses of their land as well as to perform certain actions on their land. Such land-use restrictions are restrictions that could be recorded as easements under local law. Under both the State B Program and the Organization A Program, Partnership and Subsidiary will incur significant penalties if they do not abide by the restrictions to which they have agreed. For these reasons, Credits are akin to receiving payment for granting an easement for a term of years with respect to the real property. Cf. Wineberg v. Commissioner, 326 F.2d 157, 169-70 (9th Cir. 1963) (holding amount received for granting 10-year right to use a road was rent rather than sale of an interest in land), aff'g T.C. Memo. 1961-336; Nay v. Commissioner, 19 T.C. 114, 119 (1952) (concluding amount received for granting a “right of way” for a term not to exceed three years is ordinary income because such a “limited easement” does not constitute sale of real property). Under these circumstances, treating Taxpayer's proportionate share of income with respect to the issuance of Credits as qualifying income does not interfere with or impede the objectives of Congress in enacting section 856(c)(2) and (c)(3).

CONCLUSIONS

Based on the information submitted and the representation made, we hereby rule as follows:

This ruling's application is limited to the facts, representations, Code sections, and regulations cited herein. Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. In particular, no opinion is expressed with regard to whether Taxpayer otherwise qualifies as a REIT under subchapter M of the Code. Nor is any opinion expressed with respect to the tax consequences of any dispositions of Credits, including whether a sale of the Credits constitutes a prohibited transaction as described in section 857(b)(6)(B)(iii). This letter ruling is prospective and does not provide guidance regarding Credits issued directly or indirectly prior to Year 5. Additionally, no opinion is expressed regarding whether Taxpayer or Subsidiary has established a method of accounting through consistent treatment or whether application of the rulings set forth above without obtaining the Commissioner's consent for a change of accounting method will result in an impermissible change of accounting method. See Rev. Rul. 90-38, 1990-1 C.B. 57.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representatives.

Sincerely,

Andrea M. Hoffenson
Branch Chief, Branch 2
Office of Associate Chief Counsel
(Financial Institutions & Products)

Enclosure:
A copy of this letter

cc:
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